Markets & Finance

Chevron Digs Deep


A few years ago, Chevron (CVX) Chief Executive David O'Reilly was struggling with his company's shrinking production of oil and gas. Now, after making a major acquisition and huge investments in projects everywhere from the Gulf of Mexico to Vietnam, O'Reilly is finally beginning to see signs of growth. But it's only a beginning.

With help from soaring oil prices, the San Ramon (Calif.)-based company on July 28 reported net income of $4.4 billion for the second quarter, up 18% from the $3.7 billion earned during the same period a year ago. Revenues rose 10%, to $52.2 billion. O'Reilly says the earnings improvement was driven mainly by exploration and production businesses outside the U.S.

Chevron's earnings follow similarly exceptional results from other major oil companies over the past week, including Irving (Tex.) oil major Exxon Mobil (XOM), Houston's ConocoPhillips (COP), and the European oil giant BP (BP). Exxon Mobil, for example, announced July 27 that it had a record net income of $10.36 billion during the second quarter, up from $7.64 billion during the same period of 2005.

NO MORE EASY COMPARISONS. The big news for Chevron is that its production is growing again. The company produced the equivalent of 2.67 million barrels of oil per day in the second quarter, up 10% from the same period last year. It's the fourth straight quarter that Chevron has managed to boost production, after averaging a 3% decline each year between 2000 and 2004.

Still, the issue presents a daunting challenge for O'Reilly. Production has been rising largely because of his company's acquisition in August, 2005, of Unocal, which had healthy reserves in a number of regions such as the Gulf of Mexico and the Caspian Sea. Once O'Reilly no longer has easy comparisons to previous quarters when Chevron didn't own Unocal, production growth is expected to slow down. Standard — Poor's projects production will increase an average of 6% through 2009.

One challenge is that pumping oil these days takes as much expertise in politics as in geology. Turmoil in Nigeria and the Middle East threatens supplies there. And in Latin America, Venezuela's President Hugo Chavez has changed his country's operating agreements with the oil companies, including Chevron, so Chavez now gets a larger share of production.

HEAVY SPENDING. That's one reason that Chevron gave in the second-quarter earnings call for why it expects to produce around 2.6 million barrels of oil equivalent per day during the second half of 2006, compared to 2.66 million during the first half. "It's going to be growth year on year, but not as big as many were expecting," says Craig Pennington, a global energy portfolio manager at Schroders. Chevron's stock tumbled 2.5%, to $66.05, the day of the earnings announcement.

O'Reilly is spending heavily to push production up. The company poured $7.4 billion into capital and exploration expenditures during the first six months of 2006, compared with $4.2 billion during the corresponding 2005 period. Chevron says it expects to spend $14.8 billion for the full year 2006, up 33% from 2005 and 78% from 2004. "They're running a large company, and it takes a lot to move the needle in terms of production growth," says Justin Perucki, an analyst at the investment research firm Morningstar.

On July 28 O'Reilly highlighted that the company's upstream earnings—in other words, what it gets from exploration and production—improved to $3.3 billion during the second quarter, from $2.8 billion during the same quarter of 2005. He also noted recent encouraging signs from projects where his company has invested. More natural gas was found during the second quarter at the Chandon-1 exploration well off of northwest Australia in the Greater Gorgon development area, for example. And the company has added another 15,000 barrels per day of production in the Captain oilfield in the North Sea.

DELAYED RETURNS. Chevron has also taken significant steps to develop exploration projects in other areas of the world. It signed a 30-year production-sharing contract during the second quarter with Vietnam Oil & Gas for a 50% stake in Block 122, which is offshore eastern Vietnam.

Still, O'Reilly is being cautious about his company's growth ahead. He said in the conference call with investors that he'll stick to the prediction of greater than 3% growth between 2005 and 2010. "Even allowing for the impact of the changed structure in Venezuela, we think that's good guidance," he said.

The trouble for Chevron is that many of its new projects won't bring much cash into the company's coffers for years. Once exploration workers discover oil, it can take 5 to 10 years to build the infrastructure required to extract the resource from the ground and sell it—especially when you're working in tough areas like the deepest waters in the Gulf of Mexico.

And of course, it's impossible to know what the price of oil will be in a decade. After the steep increases of the past year, will prices continue to rise, making O'Reilly's heavy investments look far-sighted? Or will they fall back to the point where expensive forays into treacherous lands cost the company money? Chevron isn't betting on dramatic change. The company says that it assumes that the price of West Texas Intermediate crude oil contracts will remain around $70 per barrel for the rest of the year.


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